Rethinking retirement assumptions

Advances in healthcare and technology have improved life expectancy in New Zealand at a staggering rate – by almost two years every decade since 1960. Investors retiring at 65 should be preparing for a long retirement. In this commentary John Berry asks how long should advisers target for their clients’ savings to last, and do historic assumptions for growth asset allocations for retirees need a rethink?

Friday, February 2nd 2018, 6:00AM

by John Berry

1 – Life expectancy at retirement is underestimated

The good news for retirees is that they are likely to live a few years longer than what news headlines tell us. This matters for advisers and how they help clients approaching retirement.

Average life expectancy in New Zealand for males is 80 years and females 83.5 years. That is life expectancy from birth. By the time a client has made it to retirement age, they will have outlasted many in their cohort - many will have already passed away from accident or illness. The life expectancy of those who make it to 65 is therefore much higher than life expectancy at birth.

For a client aged 65 their life expectancy is now 84 years (for males) and 86.5 years (for females). By making it to 65 life expectancy from that point is actually a few years longer than from birth. Great news!

2 – Prepare for a long retirement?

An issue for advisers is to then figure out how long to plan for savings to last. Just targeting the average lifespan from retirement (86.5 years for women, 84 years for men) could be high risk.

Do you add an arbitrary safety margin to the average of, say, 10 years? That would mean assuming a retirement of around 30 years, a long time for savings to last.

3 – What does this mean for investing?

The view I get from many advisers is that a low growth asset allocation is appropriate for an investor very close to retirement. This takes out the volatility and gives more certainty around future planning.

This is consistent with the approach of the sorted.org.nz online tool. If we use Sorted’s tool and make the following assumptions:

We expect to start spending KiwiSaver within 4 to 9 years

We want to invest so we “almost certainly end up with more” than we put in “despite some ups and downs along the way” and

We want a range of returns each year from a 10% loss to a 20% gain.

For these parameters sorted.govt.nz classifies us as a “conservative” investor.

The FMA’s view is that a fund identifying itself as “conservative” should have 10% to 34% allocated to growth assets (i.e. shares, property, commodities etc). KiwiSaver conservative funds fall within these parameters – here’s a sample:

KiwiSaver manager

% in growth assets¹

AMP

25%

ASB

20%

BNZ

20%

Booster

34%

Fisher Funds

22%

Kiwi Wealth

15%

Milford

13%

Simplicity

17%

The average allocation to growth assets across these conservative KiwiSaver funds is 21%. Booster is an outlier to the upside with a 34% allocation to growth assets. Milford (13%) and KiwiWealth (15%) have the lowest allocations.

If an investor close to 65 is planning for a 30-year retirement, should they hold a low or high proportion in growth assets? Is the FMA’s range of 10% to 34% too low for “conservative” investors? Or are these investors who like to think of themselves as conservative really a different profile?

The issue is whether investors approaching retirement are undercooking their growth asset allocations given a potential 30-year horizon. Asset managers in the US now recognise that a higher proportion in growth assets is likely appropriate at the start of retirement. Charles Schwarb suggest 40% and Vanguard suggest 50% should be held in growth assets at 65 ². These are much higher than the FMA’s allocations for the “conservative” investor.

4 – It’s complicated

While we can challenge the assumptions around retirement savings, we can’t come up with a “one size fits all” solution. The whole discussion is of course complicated by a retiree’s overall situation.

Do they have a mortgage, what other investments do they hold, do they continue to work, how’s their health, how much risk makes them lose sleep and what is their spending expectation?

5 – Summing up

The purpose of this commentary is to be thought provoking for advisers. It is not intended to provide answers.

The key question raised is whether growth/income allocations at retirement have become too conservative. The old rule of thumb that growth asset holdings should be 100 minus your age needs to be revisited to recognise longer life expectancies. Some now suggest 120 minus your age is appropriate.

Are growth asset assumptions being adopted in the US for 65-year olds (40% to 50%) also appropriate for NZ? It seems a worthy discussion.

John Berry is co-founder of Pathfinder Asset Management Limited, an independent director of Punakaiki Fund Limited and a member of the Code Working Group.